Reports of FTX Group’s demise has been inescapable since news first broke of potential insolvency and misuse of customer funds. This blog post provides some background on the situation as well as some thoughts on what is likely to come next. Please see our blog post here on the enforcement storm that is about to hit the cryptocurrency industry—we will be posting additional blog posts on related topics here as well.

The Background

In late 2017, Sam Bankman-Fried founded Alameda Research (Alameda), a quantitative cryptocurrency trading firm headquartered in Hong Kong. Alameda provided a platform for trading in every cryptocurrency market, and was known for pursuing aggressive trading strategies. In 2019, Bankman-Fried founded FTX, a cryptocurrency exchange currently headquartered in the Bahamas, out of Alameda. Bankman-Fried built significant wealth through Alameda and FTX—in early 2022, FTX was reportedly worth $32 billion. While it was known early on that Alameda traded on FTX, industry understanding was that the two entities were distinct aside from common ownership. Shortly after Bankman-Fried founded FTX, the CEO of Binance, Changpeng Zhao (CZ), purchased a controlling stake in the company. FTX bought out Binance’s stake in 2021, for which Binance received over $2 billion, much of which was in FTT, the native token of FTX.

On November 2, 2022, Coindesk published an article discussing a report that revealed that a significant portion of Alameda’s assets were held in FTT. The article observed that “Alameda rests on a foundation largely made up of a coin that a sister company invented, not an independent asset like a fiat currency or another crypto.” Specifically, of the $14.6 billion in assets indicated on the Alameda balance sheet, $3.66 billion was in unlocked FTT and $2.16 billion was in FTT collateral.

The Collapse

On November 6, 2022, CZ announced on Twitter that Binance planned to liquidate its remaining FTT, citing “post-exit risk management.” In response, Alameda offered to purchase all of Binance’s FTT at $22 per coin, which Binance refused. Instead, Binance began to sell its FTT on the open market, resulting in a significant price drop for FTT. While FTX had already seen an increase in withdrawals since the Coindesk article was published, withdrawals rose dramatically following CZ’s announcement and the subsequent rejection of the Alameda offer—that evening, Bankman-Fried posted on Twitter that FTX “had already processed billions of dollars of deposits/withdrawals” that day. By the evening of November 6, fears arose among FTX customers about the solvency of FTX and Alameda.

On November 7, 2022, Bankman-Fried once again took to Twitter, this time stating (in now-deleted tweets) that FTX and customer assets were fine, that FTX had “enough to cover all client holdings,” and that FTX did not invest client assets. However, by the morning of November 8, 2022, customer withdrawals were taking longer to complete, and soon FTX stopped processing them. Reuters reported that FTX had seen $6 billion in withdrawals in the 72 hours prior, which appeared to cause a liquidity crisis for FTX. Later that morning, Bankman-Fried announced an agreement to sell FTX to Binance, pending due diligence, which was non-binding on Binance. In the same thread of tweets, Bankman-Fried highlighted that “the important thing is that customers are protected.” Much of the industry was, however, skeptical of the FTX-Binance deal.

On November 9, 2022, Binance backed away from the agreement to acquire FTX after reviewing FTX’s financial records. That day, Bankman-Fried sought help from Wall Street investors, stating during a call that FTX needed $8 billion in emergency funding to meet demand for client withdrawals. It was soon revealed that Bankman-Fried allegedly transferred at least $4 billion from FTX to Alameda when the trading firm suffered losses during the industry downturn of summer 2022, some of which was customer funds. Some reports indicated that Alameda owed FTX upwards of $10 billion—FTX had $16 billion in customer funds, and reportedly loaned half of those funds to Alameda. Notably, loaning customer funds was explicitly forbidden in the FTX terms of service, which stated that title to assets remained with the customer. Apparently, Bankman-Fried moved the funds through a “back door” built into FTX’s bookkeeping system that allowed him to alter the company’s financial records without alerting internal compliance.

On November 11, 2022, FTX filed for Chapter 11 bankruptcy protection, along with Alameda and over 130 other FTX-affiliated entities. Bankman-Fried also resigned as CEO of FTX. FTX could owe money to over 1 million customers.

What’s Next?

The collapse of FTX has shaken the crypto industry, particularly because FTX was viewed as one of the most trusted exchanges in the sector. FTX customers are most directly affected by the situation. The only potential reprieve for FTX customers is through bankruptcy proceedings. After filing for Chapter 11 bankruptcy, a business must submit a reorganization plan to the bankruptcy court, agreed upon by the debtor and its major creditors, and the court must confirm the plan. Typically, the goal should be to maximize recovery for creditors. This will not be a typical bankruptcy proceeding, however. Looming jurisdictional disputes between the Bahamas and the United States are likely to add to the complications. 

Following the bankruptcy proceedings, FTX customers should, in theory, receive some portion of the company’s remaining assets. However, it remains unclear what assets, if any, will remain to be disbursed given the recordkeeping discrepancies reported in the press. Another issue arises with respect to who owns the customer deposits. If deemed to be owned by FTX, the deposits would be pooled with the total remaining assets to be divided to pay all creditors, resulting in much lower payments for customers.             

Policymakers in Washington, D.C. are shocked by the apparent deception displayed by one of the most vocal advocates for a new crypto regulatory regime. Hearings are beginning to be scheduled to learn the details of what exactly happened and why in the FTX collapse, and it can be assured that more hearings and potential legislation will be discussed in the new Congress. Finally, federal prosecutors in New York are reportedly investigating the FTX collapse, and specifically the company’s handling of customer funds. This probe joins investigations by the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), and law enforcement in the Bahamas.